Tightening Campaign
2023 marked a pivotal year in the Federal Reserve's battle against inflation, with four additional rate hikes bringing the federal funds rate to a 22-year high of 5.25-5.50%. The aggressive tightening campaign fundamentally reshaped investment landscapes across asset classes.
Inflation Moderation
- Headline CPI: Fell from 6.5% (January) to 3.4% (December)
- Core CPI: Declined from 5.6% to 3.9%, though remained above the Fed's 2% target
- PCE Inflation: Fed's preferred measure dropped from 5.3% to 2.6%
- Wage Growth: Average hourly earnings growth slowed to 4.1% from 5.5%
Asset Class Performance
Fixed Income Volatility:
- 10-year Treasury yield swung from 3.88% to 5.02% then back to 3.87%
- Investment-grade corporate bonds returned +5.4%
- High-yield bonds gained +13.4% with falling default expectations
- Money market funds offering 5%+ attracted $1.2 trillion in inflows
Equity Market Resilience:
- S&P 500 gained +24.2%, driven by large-cap tech ("Magnificent Seven")
- H1 2023: Tech-led rally fueled by AI enthusiasm
- H2 2023: Broadening rally as inflation data improved
- Russell 2000 gained only +15.1%, lagging large-caps
Alternative Assets:
- Private Equity: Deal activity suppressed, dry powder accumulated
- Private Credit: Strong performance with 11-13% net returns
- Real Estate: Commercial property values declined 10-15%, office particularly challenged
- Infrastructure: Inflation-linked revenues provided protection
Banking Sector Stress
March 2023 brought banking turmoil with Silicon Valley Bank, Signature Bank, and First Republic failures:
- Interest Rate Risk: Banks holding long-duration bonds suffered mark-to-market losses
- Deposit Concentration: Banks reliant on uninsured deposits faced runs
- Regulatory Response: Fed created Bank Term Funding Program for liquidity
- Contagion Contained: Swift action prevented broader systemic crisis
Investment Strategy Implications
- Return of Bonds: Treasury bills yielding 5.4% provided competition to equity risk premiums
- Selectivity in Equities: Top 10 S&P stocks gained 75% on average vs median of only 8%
- Private Markets Patience: Higher discount rates created potential entry points
- Currency Considerations: Dollar weakened through Q4 as rate cut expectations emerged
Sources: Federal Reserve Economic Data (FRED), Bureau of Labor Statistics, Bloomberg